“Be fearful when others are greedy, and greedy when others are fearful.”” -Warren Buffett
The relationship between capitalization rates (cap rates) and interest rates has long been one of real estate’s most consistent dynamics. Typically, the two move in lockstep — when interest rates rise, cap rates follow. When rates fall, cap rates compress. But as we enter the final quarter of 2025, that historical correlation has broken down in a way that presents a rare, and potentially time-sensitive, opportunity for investors.
The Traditional Relationship
Cap rates are a shorthand for expected investment yield — the ratio of a property’s income to its price. They are shaped by risk sentiment, growth expectations, and supply-demand conditions, but few forces exert more influence than the cost of capital.
When the Federal Reserve raises rates, financing becomes more expensive, reducing purchasing power and pushing cap rates up. When the Fed eases policy, borrowing costs decline, stimulating demand and compressing yields.
That’s the usual cycle — but not today’s.
What’s Happening Now
In November 2025, the Federal Reserve cut interest rates for the second time this year, marking a decisive pivot toward easing after two years of tightening. Officials have also signaled another likely cut in December, citing softening inflation and moderating job growth.
According to the Fed’s own reaction models — which balance inflation, employment, and growth — further rate reductions are not just possible but expected. Yet, despite this dovish policy shift, cap rates remain higher than they were a year ago.
This creates an uncommon situation where borrowing costs are lower, but income yields on real assets are higher — a combination that historically precedes periods of strong total returns for buyers.
Why Disconnect Exists
Several factors are holding cap rates higher even as interest rates decline:
- Caution fatigue: Many investors are still adjusting from the aggressive 2022–2023 tightening cycle.
- Selective market recovery: While multifamily and industrial properties have stabilized, office and certain retail assets continue to drag overall averages upward.
- Capital on the sidelines: Institutions remain hesitant, waiting for more confirmation that the rate-cut cycle will continue.
This has created a “pricing lag” where market sentiment hasn’t yet caught up to monetary reality — leaving value-oriented investors with a rare entry point.
What It Means for Investors
For investors who move now, the math works in their favour:
- Wider spreads: The gap between property yields and debt costs is unusually attractive.
- Better leverage efficiency: Lower interest expense means stronger cash-on-cash returns.
- Upside potential: As the market adjusts to a lower-rate environment, cap rates may compress — increasing property values.
In short, today’s market offers a higher yield on income-producing assets with lower financing friction — a setup that is as uncommon as it is fleeting.
As Q4 2025 unfolds, we’re witnessing a rare market phase where the Federal Reserve is easing, borrowing costs are falling, and cap rates remain elevated. History suggests this gap will close — and when it does, those who acted early will have captured the most favorable entry points.